Banking

Introduction
Banking is a key aid to trade. Banks occupy an important
position in the modern business. No country can make
commercial and industrial progress without a well-organized
banking system. Banks encourage the habit of savings among
the public. Banks provide opportunities for safe custody and
investment of money. They facilitate transfer of funds from one
place to another and help in the settlement of debts.
Learning Objectives
At the end of this lecture you will be able to:
 Define and classify banks;
 Explain the various important functions of both commercial
banks and central banks;
 Differentiate categories of bank accounts with major emphasis
on their distinctive features.
 Bank
A bank is an institution, which collects deposits from the public
and supplies credit, thereby facilitating exchange.

Banking is a business activity of accepting and safeguarding

money owned by other individuals and entities, and then lending
out this money in order to conduct economic activities such as
making profit or simply covering operating expenses.
Types of Banks
1. Commercial Banks: These banks are those established to earn
profit. The main source of earning of these banks is the interest
they charge on loans advanced to borrowers. These banks accept
deposits from the public and grant short-term financial assistance
to customers. They facilitate trade and industry activities by
performing a variety of services.
2. Central Banks: A central bank is a government institution
established to control, guide and assist commercial banks in the
country and to provide banking services and financial advice to the
government. The central bank is that bank which is responsible for
the economic stability and financial soundness of any country.
3. Savings Banks: These banks are mainly intended to provide a safe
place for keeping money and to promote the habit of thrift among
individuals. They offer very few of the services rented by modern
commercial banks. They accept small deposits, pay interest on
such deposits and offer only limited withdrawal facilities e.g.
Tanzania Postal Bank. These banks have their focus on retail
banking or individuals of small and medium sized enterprises. A
part from this retail focus, they also differ from commercial banks
by their broadly decentralized and regional outreach-and by their
socially responsible approach to business and society.
4. Merchant Banks: These banks finance mostly the trade of a
country. Their main function is to discount, accept and collect
foreign bills of exchange. They also buy and sell foreign
currencies and help business men to convert their money into any
foreign money they need, they carry on ordinary banking
business too.
5. Specialized Banks: These banks serve a special type of customer
or one aimed at providing a special type of service. Examples of
such banks include:
 Cooperative Bank: These banks are organized on cooperative
basis to provide financial assistance to their members at low
rates of interest.
 Agricultural Development Banks: Established to serve farmers.
 Industrial Banks: To provide long-term and intermediate term
loans to industrial concerns.
Functions of Commercial Banks Types of Bank Accounts
 Receiving Deposit There are three types of accounts
 Granting Loans/Credit with commercial banks.
 Agent of the Stock Exchange: 1. Savings Accounts
Market: The commercial bank Individuals open saving
acts as an agent of the stock accounts. The accounts are
exchange market. They buy more suitable to the employed
shares and debentures of different persons.
limited companies on behalf of
their clients.
Features
 Transferring of Money from one
 The account holders are
place to another place. They
required to deposit at least a
enable individuals to export or
import commodities because certain minimum initial deposit.
money can be received or paid  Money can be deposited
through banks regarding these anytime but there are some
transactions. restrictions on withdrawals.
 No overdraft is allowed but a 2. Current Accounts
balance in a saving account These accounts are offered by
may be used as security when commercial banks only and
applying for an overdraft are ideally suited to the needs
 No cheque books are of businessmen.
provided. An account holder
wishing to withdraw money Features
has to go to the bank
 A minimum initial deposit is
personally,
required at the time of
 Bank allows interest on opening a current account.
deposits held in the savings
 The account holders can
account. The rate of interest
deposit or withdraw money
differs from bank to bank.
whenever they like in any
form e.g. cash cheque, drafts
etc.
 There is no minimum balance
required to be maintained. An Features
account holder can withdraw all his  No further deposits or
deposits. withdrawal is allowed before
 Banks often allow overdraft the expiry of that period.
facilities to account holders interest  Interest paid on these
is charged on such overdraft.
accounts is higher than that
 The banks send statements to the
accounts holders on regular
paid on savings account
intervals say monthly. because banks can safely lend
money received on fixed
3.Fixed Deposits Accounts: These deposits.
accounts may be opened with not  The depositor is issued with a
less than a certain minimum receipt, which he must present
amount for a specified period. to withdraw his money at the
Usually they are opened by those
expiry of the deposit period.
who have spare money and do not
need it in the near future.
 Functions of Central Bank
Primary Function
The primary function/objective of central banks is to control
inflation, i.e. general price stabilization. This objective is
achieved through the implementation of monetary policy. The
implementation of monetary policy tools is aimed at controlling
money supply (credit control). The following methods are
adopted by the central bank to control money supply:

 Bank Rate Policy: Bank rate is the rate at which central bank
advances a loan to commercial banks. The central bank may rise
or reduce the bank rate to persuade commercial banks to rise or
reduce rate of interest to borrowers. In this way, borrowing is
discouraged or encouraged respectively.
 Reserve Requirements: All commercial banks are required to
keep a specific part of their deposit money as reserve with the
central bank. During inflation, reserve requirement is increased
and due to that money at the disposal of commercial banks
decrease and vice versa.
 Open Market Operations: This refers to purchases or sale of
securities by the central bank in the open market. During
inflation, central bank sells the securities and during deflation it
purchases the securities. In this way the central bank can increase
or decrease the supply of money in circulation.
Secondary Functions
 Banker to the Government: The central bank provides facilities
for the government in the same manner as a commercial bank
does for the businessmen. It receives deposits on behalf of the
government e.g. taxes and advances loans to the government. It is
the financial adviser to the government in all economic policy
matters, which can be achieved by monetary tools.
 Bank to Commercial Banks: A commercial bank provides
banking facilities to commercial banks. It is the custodian of the
reserve of the commercial banks. It is central clearinghouse in
which it settles disputes between two commercial banks as soon
as they arise.
 Exchange Control: The central bank is responsible for
maintaining the foreign exchange reserves at a desirable level.
Central bank adopts the exchange control system to achieve this
objective.
 Note Issuing Agency: The central bank has monopoly to issue
currency notes and coins in the country.
 Direct Action, Moral Persuasion and Publicity: Central bank can
issue orders to the commercial banks to advance more or less
loans and it is known as direct action. Sometimes, central banks
can request commercial banks to behave in a specific way in the
interest of the country and it is known as Moral-persuasion.
Some reports are published by the central bank periodically and
commercial banks can change their policy according to these
reports and this method is known as publicity.
 Lender of the Last Resort: A central bank is not basically a
money-lending institution but it does sometimes lend money to
the government, commercial banks and other financial
institutions. The central bank extends loans to such institutions
and government when other loan sources are not in place to
extend loans.